Supply Response of Cocoa in Papua New Guinea Boniface Aipi* Tanu Irau† and Ludwig Aur Aba‡ Working Paper BPNG2012/02 November 2012 Bank of Papua New Guinea Port Moresby Papua New Guinea The Working Paper series is intended to provide the results of research undertaken within the Bank to its staff, interested institutions and the general public. It is hoped this would encourage discussion and comments on issues of importance. Views expressed in this paper are those of the authors and do not necessarily reflect those of the Bank of PNG. This paper must be acknowledged for any use of the work and results contained in it. * Boniface Aipi is the Manager for Projects Unit of the Research Department at the Bank of Papua New Guinea. † Tanu Irau is a Senior Research Analyst with the Projects Unit of the Research Department at the Bank of Papua New Guinea. ‡ Ludwig Aur Aba is a Research Analyst with the Research Analysis Unit of the Research Department at the Bank of Papua New Guinea. Acknowledgements Many people have assisted us with this research project. First and foremost special thanks go to the smallholder cocoa farmers of Tokiala, Taui, Ramale, Ulaulatava, Bitavavar, Warangoi Floodway Block, Unamami, Kokopo, Rapopo in East New Brit- ain (ENB) province. The same gratitude is also extended to smallholder farmers of Autonomous Region of Bougainville, and East Sepik province, especially farmers in the following council wards; Boiken/Dagua, Turubu, Wewak, Numbo, Yarapos and Kanawagi. In Madang, we are grateful to smallholder farmers in the following corpo- rative societies; Banab, Iyal, Jahil, Mesam and Bargam. These smallholder farmers generously gave us their time and shared their knowledge and ideas about cocoa production with us. We also appreciate the officers of the Cocoa and Coconut Re- search Institute (CCRI), and Cocoa Board who also assisted us with the surveys, and assisted us in securing interviews with smallholders and some plantations. To all the extension officers and divisional managers that accompanied us to smallhold- er farmers in ARB, ENB, ESP and Madang, we extend our unconditional gratitude and appreciation. We would also like to acknowledge those officers of the Bank of Papua New Guinea, who contributed helpful comments on a draft of the paper and the Bank of PNG for funding the research project. Any remaining errors are ours. ii Abstract Both quantitative and qualitative analyses were done to study the impact of interna- tional price movements and other variables on the production and supply of cocoa. An Error Correction Mechanism (ECM) model confirmed the cross sectional data study for the cocoa industry that cocoa production and supply in both the short and long-run does not respond to international price movements but to other non- price variables that cannot be quantified due to lack of consistent time series data. Overall, supply response to changes in international prices is inelastic in the cocoa industry. Both the long and short-run estimates are consistent with the survey re- sults. Price factors aren’t influential in the production and supply of cocoa exports. In Papua New Guinea, non-price factors are pivotal in the determination of cocoa production and export supplies. Weather also plays an important role in determining production and supply of cocoa exports in PNG in the short-run. Results were also confirmed by growers during the field survey. It was found in the survey that price of cocoa is not the only factor that affects the production, other non-economic and economic factors are also responsible. iii Table of Contents 1.0 Introduction 1 2. 0 Economics of Cocoa Production and Supply in PNG 2 3.0 Survey Description 6 3.1 Survey Results and Discussions 6 3.2 What determines Cocoa Production and Supply? 8 3.2.1 Prices of cocoa 8 3.2.2 Prices and Cultivation of other commodities 10 3.2.3 State and Use of technology 11 3.2.4 Use of Chemicals 12 3.2.5 Communication 12 3.2.6 External Support 12 3.2.7 Labour input and return on labour 13 3.2.8 Number of producers 14 3.2.9 Management skills and time management 15 3.2.10 Customs/traditions 16 3.2.11 Inputs and prices of inputs 16 3.2.12 Land accessibility; 16 3.2.14 Weather patterns 17 4.0 Constraints 18 4.1 Cocoa pod borer 18 4.2 Lack of Government assistance 18 4.3 Dilapidating Conditions of Infrastraucture (roads and bridges) 18 4.4 Absence of Financial inclusion 19 4.5. Lack basic accounting and management skills 19 5.0 Methodology 19 5.1 The model 20 iv 5.2 Discussions of the results. 25 6.0 Conclusion and Recommendations 26 Appendix 28 Reference 29 v 1.0 Introduction Cocoa production is a major source of employment and income for growers, buyers and exporters, contributing immensely to foreign exchange earnings of Papua New Guinea (PNG). The aim of this paper is to establish the effect of changes in the international price movements of cocoa to production and supply of cocoa exports. In this study on cocoa, both quantitative and qualitative analyses were done to examine the impact of international price movements and other variables on the supply and production of cocoa in PNG. Furthermore, the paper will also try to highlight other non- price factors that affect cocoa production and export supply in PNG. The Bank of PNG conducted field surveys to establish the factors that determine the production and export supply of cocoa, including movements in international price of cocoa. The survey found that there were a number of other independent factors (economic and non-economic) that influence the producers’ decision to produce and supply cocoa. This analysis is based on interviews with company executives, extension officers, Cocoa and Coconut Research Institute (CCRI), Cocoa Board, Cooperative Societies and smallholders during the field visits to most of the cocoa- producing provinces, including Autonomous Region of Bougainville (ARB), East New Britain (ENB), Madang and East Sepik Provinces. Ninety (90) percent of cocoa production and supply in PNG is by smallholders and 10 percent by plantations. Based on a cross section data study on smallholder, cooperative societies and plantations in major cocoa producing provinces, results show that, apart from international price movements, a wide variety of factors influence cocoa production and export supply in PNG. It was found that the need for revenue to meet community obligations, condition of infrastructures like roads and bridges, labour, land, state of technology, age and stock of cocoa trees, etc. do affect cocoa production and export supply. Also the farming methods within which agricultural production decisions are made in PNG is likely to differ from those in other countries. In addition, the various methods of farming may have changed over time as a result of changes in technology and resource constraints. An Error Correction Mechanism (ECM) model confirmed the cross sectional data study for the cocoa industry, with cocoa production and supply in both the short and long-run not responding to international price movements but to other non-price variables that cannot be quantified. There is substantial literature on supply response of agricultural commodities but little of this is directly relevant to PNG’s export commodities. Country specific data on supply elasticities are needed to ensure analysis based on such parameters will be of relevance (Hone, Haszler and Natasiwai, 2008). A number of studies have been done on cocoa production in PNG on all producer levels, including various publications by Cocoa Board, Cocoa and Coconut Research Institute (CCRI). However, there is only a few known publication on ‘Supply Response of Cocoa”, i.e. by Ruhle and Fleming (1999) on Cocoa Supply Responsiveness to price and exchange rate in Papua New Guinea: Tree crop policy options project in Papua New Guinea. They use cocoa prices, exchange rate and the price of fruits and vegetables as the main economic variables to determine supply response in PNG. In their study, two econometric models were 1 employed to analyze smallholder cocoa supply response. The first model looked at a separate cocoa export price and exchange rate variable, while the second looked at a single cocoa producer price variable. However, in this study, it was also found that there are other independent non-economic variables that affect the production and supply of cocoa in PNG. This paper is organized as follows; the first section discusses the economics of cocoa production and supply in PNG, a descriptive overview of the cocoa production and export supply, with trend in price developments. The second section looks at the survey results and discussions, dissecting the factors that affect cocoa production and supply in PNG, followed by a section on the major constraints that challenge the productive capacity of the cocoa industry. Time series data is not available for all the variables discussed as major determinants of cocoa production and supply, so the next section will use those variables that have available time series data to develop a model for the cocoa industry supply response function. This will be followed by conclusion, recommendations and highlight areas of future research. 2. 0 Economics of Cocoa Production and Supply in PNG Theobroma cacao, commonly known as cocoa is believed to have been brought to PNG in the 19th Century by the Germans, which made PNG one of the cocoa producing nations. PNG has the ideal warm and humid climate, temperature, and frequent rainfalls for cocoa to grow and produce some of the most fine-flavored cocoa in the world. Since its introduction, it has gradually become one of PNG’s major export commodities, following coffee and palm oil, bringing in revenue and much needed foreign exchange for the government, employment and income for producers.